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Kettle of Debt Has Something for Everyone

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By Lowell L. Kalapa

     An addition made by the 1978 Constitutional Convention which proved to be quite controversial at the time has now become a much sought after means of financing private projects which benefit the community at large.

What is now known as special purpose revenue bonds are more commonly known as industrial development bonds on the mainland. These are bonds which are issued by state and local government on behalf of private enterprises for projects which have been determined to be of a public purpose. The advantage for the enterprise is that the rate of interest is far more favorable than conventional financing. This is because the interest income is exempt from federal and state income taxes.

However, unlike other debt issue by state and county government, repayment of the debt is the sole responsibility of the private enterprise for whom the debt has been issued. Further, government is not on the hook to repay the debt and does not guarantee the repayment. Thus, the interest rate on special purposes bonds tends to be slightly higher than debt that is by and for government projects, but still lower than what would otherwise be charged for conventional financing.

So what’s the catch? Well, as noted above, the projects or enterprises have to be determined to be in the public interest. For example, a private hospital that provides health care that benefits all the residents of the community is deemed to be serving a public purpose. The type of activity has to be determined to be of a public purpose before special purpose revenue bonds can be authorized. Once the activity – be it health care, energy generation, or economic development – is found to be in the interest of the public, lawmakers can then authorize a specific amount of special purpose revenue bonds to be issued.

When the 1978 Constitutional Convention considered establishing these types of bonds, charges were made that public debt was going to be used to benefit private companies who already make profits from consumers. Many argued against the idea seeing the issuance of public debt that would benefit a private company as a use of public resources for private benefit. However, proponents of the concept argued that utilizing the tax exempt status of a government issue of debt merely reduces the cost of goods and services which benefit the community – be it health care, generation of energy, or the creation of jobs.

In the end, delegates approved the constitutional provision allowing the issuance of special purpose revenue bonds. Over the years, numerous private groups have come before the state legislature seeking approval of their projects as first meeting a public purpose and then securing an authorization of bonds. Some of those proposals have been dubious to say the least. On the other hand, special purpose bonds have proven to accomplish exactly what convention delegates intended, a means of financing private projects which serve a public purpose.

Although the issuance of special purpose revenues bonds does not incur a call against the resources of the state or county government, over the years the budget department has taken great care in evaluating the feasibility of the projects and a company’s ability to repay the debt. So while an entrepreneur may be able to convince lawmakers to approve the public purpose of a proposal and authorize the issuance of bonds, it is not a “done deal” until budget officials determine if the project will be able to make the repayments.

Why the second review? Even though the state is not responsible for the repayment of the debt, any default of special purpose revenue bonds issued by the state or county government will send warnings to investors that local budget officials did not do a good job of making sure the enterprise could make the debt service payments. And if that is the case for these types of bonds, what does it say about publicly backed bonds for state and county projects?

As an interesting observation, when money began to dry up in the mid-1990’s, lawmakers wanted to help nonprofit organizations which provide services to the community through state contracts. These nonprofits were given authorization to use state bonds to help with capital projects. These were bonds that are an obligation of the state and therefore are repaid with taxpayer dollars. No thought appears to have been given to using special purpose revenue bonds even though special purpose revenues were available and would have required those nonprofit organizations to be responsible for the repayment of the debt service rather than taxpayers.

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